Seeking Out the Silver Lining

04 / 05 / 2020

Amidst unprecedented economic uncertainty, the value of many assets is significantly lower now than what it was in a pre-Covid world. UK residential property is no exception, with property prices expected to drop further before we see the green shoots of a recovery.

This might prove incentivising to property investors and could also provide impetus for the restructuring of property “envelopes” that for a while have no longer delivered tax efficiency, but which were previously regarded as too costly to disband, where underlying properties stood ‘pregnant’ with gains.

Similarly, now may be the time to engage in lifetime giving to family members of directly-held or indirect UK residential property interests, without this triggering a large chargeable gain in addition to the donor’s continuing exposure to UK inheritance tax (IHT) on the value of the gifts for up to 7 years.

The planning opportunities offered by the current state of the UK residential property market are clearly not to be underestimated, with the UK government likely to emerge from lock-down in need of replenishing its finances through tax increases following unprecedented financial bailout measures.

Much of Prime London residential property is owned by overseas investors. Some of the Covid-related tax considerations which overseas owners should bear in mind when looking to implement gift planning in relation to their UK residential property interests include the following:

1. Valuations

Inspecting property safely and (with transaction volumes down) accessing data on comparables is likely to present practical challenges in the current climate. These are not insurmountable, however.

More importantly, there is the risk of valuations prepared in times of significant uncertainty being treated as less reliable by HMRC, and more prone to challenge.

Particularly for longer-held properties, which may still stand at a gain, owners should resist the temptation of opting for desktop-only valuations, which are not followed by a physical inspection of the property when social distancing restrictions are lifted.    

2. Maintaining non-residence  

Gains or losses realised on the actual or deemed disposal (including on a gift to a connected person) of UK residential property interests by non-UK residents are within the scope of the Non-Resident Capital Gains Tax (NRCGT) charge. In calculating the gain or loss, there is rebasing to 6 April 2015 values, meaning that only gains calculated as arising between that date and now are within the scope of taxation.

However, an individual’s residence status for the tax year will need to be anticipated, not least because an NRCGT return must be submitted within 30 days of the disposal.

Individuals planning to be non-UK tax resident in the 2020/21 tax year, who happen to be locked down in the UK, may find that their UK tax residency status for the year is not what they expected it to be, depending on their personal circumstances, how long travel restrictions remain in place for and any relaxations to the UK’s Statutory Residence Test that may be introduced.

Where an individual is prevented from leaving the UK by “exceptional circumstances” beyond their control (and HMRC has helpfully published specific guidance in the context of the Covid restrictions), additional days spent in the UK, up to a maximum of 60, may be disregarded for day-counting purposes under the Statutory Residence Test. Whether they are, however, will be fact-specific.

Having spent more days in the UK earlier in the tax year, with necessary trips still having to be made later in the tax year, individuals may also find it difficult to adhere to the permitted number of days in order to remain non-UK resident for the tax year. Individuals who are having to carry out work while in the UK may also inadvertently trigger an additional, “work tie”, causing the permitted number of days of UK presence to be reduced.   

Resumption of UK tax residence in the 2020/21 tax year as a result of the Covid pandemic could further impact those who have made gifts of UK residential property interests in a tax year of so called “temporary non-residence”, where the individual returns to the UK within less than five years. In that case, the pre-April 2015 portion of any gain realised on the gift and not charged to NRCGT will be subject to Capital Gains Tax (CGT) in the tax year of return to the UK.

3. Crystallising losses

Where gifts of UK residential property interests to connected persons result in deemed NRCGT losses, there are restrictions on the donor’s ability to utilise the loss against future gains. There is also the issue of the donee’s base cost in the asset being lower, which may lead to higher gains arising on a future sale.

Particularly where individuals do not anticipate being able to utilise such “clogged” losses, they may query the need for submitting an NRCGT return. It is HMRC’s view that an NRCGT return is required regardless. Recent case law suggests that this may not be the correct interpretation of the law. Testing HMRC’s resolve on this may be unwise, however.

Conclusion

With UK residential property interests (however held) now firmly within the IHT network, lifetime giving and co-ownership arrangements for personal use property have been on the increase.

While the current, low-value environment is a concern for those likely to need to sell property for short-term liquidity, there is clearly a silver-lining for families looking to mitigate the incidence of IHT on retained property where transfers to the next generation can be made incurring no, or lower, CGT cost.

For overseas property owners accessing the full CGT benefits of the current situation may well depend on their remaining non-UK resident at a time when freedom of movement is highly unpredictable. Taking into account the broad practical reality of individuals’ lifestyles when considering such gift planning will therefore be key.